Chapter 18 & 16 Financial Markets/ Business Cycles Flashcards
1
Q
How to calculate how much a project can be financed through borrowing
A
Divide the amount available to invest (entrepreneur)
by x
equate to how much the lender requires as a total net return
2
Q
What is the difference between debt and equity finance?
A
Debt finance involves borrowing to invest:
- keep more control of company
- increases bankruptcy as equity levels tend to be lower
Equity finance:
- Selling of shares to finance investment
- makes it harder to go bankrupt
- control of company partially ceded to shareholders
3
Q
Limited Liability (Define)
A
Means the investor will never lose more money than they originally invested
- i.e. will never have to service any of the firm’s debt
4
Q
How does getting rid of limited liability affect investment and risk taking?
A
Removing decreases expected value for shareholder
- shareholder will not invest without limited liability
5
Q
What is more likely to cause a financial crisis…
fall in shares by 30%
fall in real estate price by 30%
A
Real estate investments.
- heavily debt financed
- when real estate prices go down, losses spreads to banks and other institutions
